There has been a trend towards economic integration over the past decades. In this lesson, we'll learn about economic integration, its theoretical basis, and different levels of integration.

What Is Economic Integration?

Economic integration involves agreements between countries to permit, to varying degrees, the flow of capital, labor, goods, and services across their respective international borders.

Theory of Economic Integration

The argument in support of economic integration can be very complex, but we'll outline the general theoretical basis. Every country is better suited to engage in certain activities than other activities. Some countries are rich in natural resources, some in labor, and some in capital, just to name a few. We'll keep it simple and restrict our discussion to capital (money available for investment) and labor (workers).

If labor and capital are free to move across international borders, each country can capitalize on its advantages. Countries with a great amount of capital will focus on economic activities requiring a great amount of capital investment, such as pharmaceuticals, aerospace, and emerging technologies. They will export capital-intensive goods and services and import labor-intensive goods and services. Since such a country doesn't focus on labor-intensive businesses, its labor supply will increase, causing wages to go down as more people compete for the same jobs.

On the other hand, countries with an abundance of labor will focus their economic activities on industries that rely on a great amount of labor, such as manufacturing, because labor is cheap. However, eventually the supply of labor will decrease, which will cause wages to go up. The country will also increase its capital, from the profits it generates from its exports, and that will permit more investment.

The theory hypothesizes that eventually the ratio between wages and profits should equalize among the participating countries, resulting in fair and balanced trade. In other words, according to the theory, there will eventually cease to be a disparity between labor costs, capital investment, and wealth among nations.

Types of Integration

As you might expect, there are varying degrees, or levels, of economic integration. Each type of integration represents a particular level of economic integration. You can think of economic integration as being on a continuum, in which no integration is at one end, and complete economic integration is at the other end.

Free Trade Agreements

Most efforts at economic integration occur today through the use of free trade agreements, which are agreements entered into between countries regarding specific trade issues, such as reduction of tariffs (a type of tax on imported or exported goods and services) and quotas (non-tariff barriers between countries) that limit imports. Trade agreements can be bilateral (between two countries) or multilateral (between several countries). Countries that are not a party to the agreement will be subject to higher tariffs and other trade barriers.

Free Trade Areas

A free trade area eliminates barriers to trade among the members such as tariffs and quotas. Members of a free trade area make their own policies concerning trade with other countries outside of the free trade area. You should note that a free trade area may be limited to specific types of goods and services. The best example of a free trade area is NAFTA, the North American Free Trade Agreement.

Customs Union

A customs union is formed by countries that not only eliminate trade barriers between the members but also have a unified trade policy with countries outside of the union. For example, a customs union will establish a common tariff that is applied to all imports coming into each member country. The tariff revenues may be split among the members, according to a formula agreed to by the members. An example of a customs union is the Andean Community consisting of Bolivia, Colombia, Ecuador, and Peru.

Common Market

A common market has all of the characteristics of a customs union but also eliminates barriers to the movement of capital, labor, and technology. Restrictions on immigration, emigration, and foreign investment between members are lifted. Mercosur (short for Mercado Común del Sur (or Common Market of the South) is a South American group of nations that is an example of a common market.

Economic Union

The highest level of economic integration occurs in economic unions. In addition to all of the economic integration features found in common markets, members of an economic union must be able to maintain consistency with monetary policy, fiscal policy, and tax policy. An economic union also uses a common currency. You should note that an economic union requires that member states give up a significant amount of their independent sovereignty. The European Union is an example of an economic union.

Lesson Summary

Let's review. Economic integration constitutes agreements between different countries that reduce or eliminate barriers to trade and other economic activity. Supporters of economic integration argue that free trade will eventually result in an equalization of wealth across countries. There are different levels of economic integration, including trade agreements, free trade areas, customs unions, common markets, and economic unions.

Summary:

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